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The future challenges for oversight

Chapter 3 – The future challenges for oversight

Prepared by Denis Beau


1 Introduction

Central banks are involved in the market infrastructures and payments ecosystem in three major ways. A core role has always been to provide a safe settlement asset for many payment and settlement systems. Many central banks are also operators of one or more systems. In pursuit of their public policy objectives in relation to monetary and financial stability, central banks have also sought – through the use of oversight activities – to influence the design and functioning of payment and settlement systems, to ensure that they are safe and efficient.

With the dynamism and expanding role of the private sector in providing payment and settlement over the last decades, oversight activities have become a core responsibility of central banks and a function which has had to be performed in a more formal and systematic way. However, the transformation that is underway of the market infrastructures and payments ecosystem challenges (in a number of old and new ways) how this oversight responsibility can be carried out effectively and calls for adaptations in the implementation of the principles which govern the activity.


1.1 Towards a new payment and settlement landscape

The payment and settlement landscape is currently dominated by a bank-based ecosystem; an interchangeable use, at par, of commercial bank and central bank money as settlement assets; and an anchor role for central bank money – which is the sole settlement asset with legal tender status. It is certainly an understatement to say that this landscape may be significantly altered, given the technological developments and changes in consumer preferences that are taking place. For instance, in the field of payments, both the “front-end” arrangements – that ensure the interaction between the payer or payee and the payment service provider, to initiate or receive payments – and the “back-end” arrangements – which transfer information and funds between the payer and the payee – are changing.

In addition, with the emergence of so-called “crypto assets” like the bitcoin and so-called “stablecoins”, we may also see new settlement assets develop which may compete against and possibly (according to their promoters) replace commercial and central bank money as settlement assets at the centre of our payment and settlement systems. These possible developments may accompany the trend toward the “tokenisation” of financial assets and the possible emergence of new tradable assets associated to specific rights, such as utility tokens. In this vein, a series of private and public initiatives tokenising financial assets have emerged in the world over the last three years, with the aim of generating new business opportunities while improving the functioning of market infrastructures.

Fintechs and global technology firms (the so-called “big tech”) are likely to be important contributors to the changes underway. As new players in the payment and settlement ecosystem, they are progressively bringing new business models, from fee-based to data-driven, where payment services are provided free of charge in exchange for personal data that offer deep insights into users’ preferences. Due to their global footprint, they are uniquely positioned to offer services in the area of global cross-border transactions, where current solutions are seen as not efficient enough.


1.2 Existing risks amplified; new risks revealed

For its advocates, the current evolution of the payment and settlement landscape promises better consumer experiences and greater efficiency of financial market infrastructure. However, alongside the opportunities to improve our payment and settlement systems, this evolution also brings with it new risks, while also amplifying old ones.

Among the old risks, we should consider in particular the rise of interdependencies. Indeed, digitalisation and tokenisation of the payment and settlement ecosystem driven by Tech firms may not lead to a more decentralised system. On the contrary, as the centripetal forces of network effects may benefit large conglomerates the most, it could lead to greater dependency on a few key players (and their systems and services) without, by definition, any readily available alternatives. Cyber risk is also likely to be on the rise: as payment solution or market infrastructures incorporate a large part of new technology in their components, they tend to be more and more exposed to cyberattack. In particular this concerns market infrastructures relying on complex IT systems, often composed of different layers of legacy systems, databases, gateways, etc. Furthermore, they are by nature in the nexus of the financial systems, with communication standards and procedures with financial entities, other market infrastructures and other stakeholders. A cyberattack against them may have widespread consequences for the financial system, with potential cross-border, knock-on effects.

The new risks to financial stability and monetary sovereignty are created by the possible issuance of “global” stablecoins with a large scale and reach. In addition, the emergence of global stablecoins also raises challenges for other public policy objectives, such as the prevention of money laundering and terrorist financing, combatting fragmentation of payment services and lack of interoperability, and promoting competition. The adoption of distributed ledger technology (DLT) in financial market infrastructures could also recreate silos due to heterogeneous non-interoperable solutions, which could generate a risk of liquidity fragmentation in interbank payments. Issues related to liquidity fragmentation would be most acute during times of financial stress, and hinder the smooth circulation of liquidity necessary to the handling of the situation by various entities, thereby potentially worsening financial crises. Such an evolution would collide with the central banks’ commitment over the last few decades to integrated financial markets and efforts to maximise the availability of liquidity.


1.3 What are the challenges for overseers?

The risks associated with payments and markets infrastructures have always evolved, over time and, so far, overseers have been able to smoothly and regularly adapt their framework and tools as needed. Dealing with an evolutionary environment is, in a way, in their DNA. But the disruptions we might be witnessing can challenge these framework and tools in new ways. Let me mention here three issues which might deserve special attention going forward:

  • First, the balance between the public policy objectives of efficiency and safety. This balance may become more difficult to maintain, explain and impose, when faced with innovations whose possible strong benefits in terms of efficiency may come at the price of more exposure of the payment and settlement ecosystem to destabilising risks and loss of sovereignty. This may expose overseers to criticism of conservatism and bias regarding innovation: firstly, in favour of “old” technologies which have proved their robustness but might not be in tune with new developments; and secondly, in favour of well-established and regulated incumbents.
  • Second, the appropriate scope of oversight activities. The increasing complexity of the payment and settlement ecosystem, the growing importance and concentration of third-party service providers and the pace at which changes are taking place requires the development of a flexible and extensive approach to the relevance of the components of the payment and settlement ecosystem to the broad public policy objectives of safety and efficiency pursued by oversight activities.
  • Third, the powers and capacity to carry out oversight responsibilities effectively. Big tech may not only disrupt the business model and the value chain of payments, but is also made up of entities which, because of their size and/or of the way they are organised, may render the application of rules or overseers’ expectations based on moral suasion more difficult.


2 How to adapt oversight activities to the challenges of the new payment and settlement landscape?

In the context described above, central banks should benefit by continuing to adhere to the principles that have inspired their framework for conducting oversight activities over the last decades: transparency of oversight policies, reliance on international standards (where available), effective powers and capacity to perform oversight activities effectively, consistent application across payment and settlement systems, cooperation with other central banks and other relevant authorities. Such principles remain appropriate to meet the challenges raised by the evolving payment and settlement landscape. How these principles are implemented may need to be further developed in the two directions discussed below though, to ensure their effectiveness.


2.1 Leveraging the cooperation between authorities

Cooperation between authorities is by no means a new tool. However, the growing interconnections and interdependencies between market places – mainly through the possible development of prominent third-party service providers or private infrastructures working as closed-circuit systems – make the building of trust and cooperation between overseers more critical than ever in ensuring that, both in normal times and in crises, the necessary steps are taken on a global scale. The momentum in this field must be preserved over time and can benefit from such initiatives as the publication, in 2019, of a compilation of authorities’ experiences with cooperation (“Responsibility E” of the PMFIs). The same holds true with macro-prudential authorities and the ambition of introducing new frameworks (or enhancing existing ones) as well as tools aimed at limiting systemic risk. The work already done in this regard by the Financial Stability Board (FSB) – on an international scale – and by the European Systemic Risk Board (ESRB) – in Europe – has been pivotal and needs to be consolidated in the future.


2.2 Developing an “augmented” oversight approach which would have three major aims:

2.2.1 Complementing the regulatory answer

In the field of payments in particular, the European regulation is made up of several elements designed according to a “product/service-based” approach, which represents a form of regulatory fragmentation while the borders of the different categories tends to blur.

For instance, the Commission’s recent proposal for the regulation of crypto-assets (MiCA), is an essential step toward the enhancement of the rules and the delineation of the types of actors the latter will apply to, be they issuers of “asset-referenced tokens” or of “e-money tokens”. But it may also foster the risk of arbitrations of market players with existing regulations (such as the e-money Directive) in case of unequal requirements. The extent to which this future regulation should be accompanied by an evolution of the oversight approach which might limit such risk, and how, will have to be dealt with.

As a first answer, the European Central Bank already intends to introduce an innovative payment oversight framework for electronic payment instruments, schemes and arrangements (the PISA framework). This future framework, still under consultation, reviews some of our oversight tools and responds to the various technological and market changes by redefining the scope of our oversight activity and providing a futureproof, harmonised and proportional framework inspired by the principle of “same business, same risks, same rules”. This new approach to oversight should help to better handle the issues raised by stablecoins.


2.2.2 Integrating the oversight function

The oversight function remains traditionally split according to the nature of the entities and services that are being overseen, which reflects the stacking of sectorial regulations: central securities depositories, central counterparties, trade repositories, payment systems (systemic or not), payment schemes and arrangements.

In light of the analysis displayed above, we may need an integrated oversight approach: considering the circulation of money as a whole and taking into consideration the diversity of technologies and services, in order to ensure that the set of common principles applicable to the market stays appropriate. This could be done for instance in two ways: first, by diversifying the experience and profiles of overseers, developing common analytical tools, an advanced technological watch in cooperation with market participants, international cooperation (with the Bank for International Settlements (BIS), the International Organization of Securities Commissions (IOSCO), the Financial Stability Board (FSB), etc.); second by strengthening cooperation with other authorities (via Memoranda of Understanding, multi-authorities supervision committees, etc.) and sharing the experience and market trend analyses on horizontal themes such as security of retail payments (e.g. on regulatory frameworks, data protection issues, cyber information and intelligence, etc.).


2.2.3 Using new tools and experiments

In the field of payments, market players increasingly rely on data analysis and artificial intelligence to automate their processes. In particular, the race for immediacy and user-friendliness pushes them to exploit payments data and to implement innovative tools in order to detect fraudulent transactions.

These technologies also have interesting use cases with regard to the oversight function. Indeed, these tools can, for instance help public authorities to improve on-Chapter 3 – The future challenges for oversight 321

site and off-site verifications by combining human and automated controls. Furthermore, artificial intelligence already has proven applications in terms of predictive simulations and readability of the regulation. Henceforth, overseers face the challenge of building such technical capabilities while limiting associated risks (e.g. accountability, bias, risk amplification, etc.).

As a way to develop the necessary in-depth understanding of innovation, the central banks’ oversight function can also greatly benefit from experimental activities. There are different approaches in this regard, but the conducting of experiments is pivotal. Those carried out by the Banque de France on wholesale central bank digital currency and those of the Eurosystem on a possible digital euro, pursue concrete objectives from a payment policy and payment system operator perspective, but are also useful to identify risks that will have to be addressed from an oversight perspective.

If it is premature at this stage to provide some indications on where this could lead us to, it can already be stated that the growing digitalisation of money encourages overseers to adapt their practices. On the one hand, they need to reaffirm their support for innovative methods and remain open to external ideas, in order to benefit from cross-fertilisation with academics and other supervisory authorities. On the other hand, they need to foster the development of specialised human resources and to facilitate the exchange of knowledge, notably on cutting-edge topics such as data science and artificial intelligence.


3 Conclusion

The oversight function has already demonstrated its capability to adapt to a rapidly evolving environment and has proved effective as a central bank activity to foster financial stability.

To preserve this effectiveness, oversight activities will need to adapt to a fast-changing payment and settlement landscape. Its legitimacy in the longer term will certainly be conditioned by its transparency, its ability to cooperate and to adopt innovative approaches and the tools it has available; beyond its commitment to the promotion of efficiency and safety of payment and settlement systems.

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ArticleDenis BEAU, Sous-gouverneur de la Banque de France
The future challenges for oversight
  • Publié le 23/07/2021
  • 368 page(s)
  • EN
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